Your Tax Guide: IRS Publication 17 & the AMT

IRS Publication 17 is a nice fat booklet published by the Internal Revenue Service which explains in detail everything you’ll ever want to know about your federal individual income taxes.  It’s almost 300 pages long and the Alternative Minimum Tax is briefly discussed on half a page of the publication.  While Pub 17 gives a good overall view of the AMT, the instructions for IRS form 1040 give a better in-depth explanation of the AMT.  The IRS form for figuring and calculating the AMT is also helpful: IRS Form 6251.

IRS Publication 17

What’s really nice about IRS Publication 17, however, is that it’s written in some nice plain English.  How’s that for a change at the IRS?  Soon you won’t be needing people like to to interpret what’s going on  over there at the IRS!  Well that day’s still a bit far off so let’s take a look at Pub 17 and the Alternative Minimum Tax.

Pub 17 does a good job of nutshelling the concept of the AMT:

Tax law is complex.  One idea that makes our tax system so hard to understand is all the little types of income that receive special treatment under our tax code.  Every year, lawmakers and people that affect policy lobby for special treatment of their constituents.  For example: a group might want income from rental properties to be tax-favored income so they can save money on taxes.  This group might be comprised of oh, let’s say…landlords?  Yes, everyone would like to change the tax code to benefit his or her own type of income.  Well some people do get what they want..usually the rich and powerful people who have lots of influence over how tax code gets written.  That would be…Big Business.

Tax-Preference Items & Pub 17

So, back to Publication 17 and the AMT.  Now, after 100 years of writing special treatment of certain types of income into our tax code, we have the world’s most complicated income tax.  We also have a myriad of ways for people to loophole themselves out of paying their fair share of federal income taxes.

That’s because while lawmakers have been busy writing into law special treatment of certain types of income, they’ve also been busy writing into law all sorts of deductions to income as well.  We can deduct all sorts of things now from our taxable income.  In addition to income adjustments which leave certain types of income off the taxable total, now we’ve also got more ways to remove money from the total: things you spent money on.

Tax-favored expenditures like medical expenses, state and local taxes, and depreciation can be subtracted from your Adjusted Gross Income as well.

So, through these types of adjustments, it’s possible for some wealthy people with smart accountants to whittle down their income tax liability to almost nothing.

Enter the Alternative Minimum Tax (AMT).  The AMT comes in and says

Put back those tax preference items and adjustments to income!

With the addition of certain tax preference items (e.g. state and local taxes) there is an alternative tax and if it winds up being more than the regular tax it’s the one that counts.  That, in a nutshell, is the AMT as described by the AMT.

IRS Form 8801: Credit for Paying the AMT

Sometime you can get credit on your federal income tax return for having paid the AMT in previous years.  If you paid AMT in the past, and if you paid it for a certain reason explained below, you may be eligible to use IRS form 8801 to get an AMT credit.

How Do I Know if I’m Eligible to Use IRS Form 8801 for the AMT Credit?

There are two considerations:

  1. Did you pay the AMT in a previous year?
  2. What kind of AMT did you pay?

 

Well of course it’s easy to tell whether you’ve paid the AMT in previous years.  As for the second consideration, that’s way more complicated.  But don’t worry: I’m here to help with that!

The basic gist of the AMT credit is to find out how much of the AMT you paid in the past was because of things that had to do with timing.  These things are called deferral items.  If you look at IRS form 6251, lines 15 to 27 are deferral items.  So, if you look at your form 6251 from prior years’ tax return and you have entries in lines 15 to 27 then you may be eligible to use IRS form 8801 to get credit for those entries.

These deferral items are credited because there might be a difference in timing between the AMT system and the regular tax system.  Depreciation methods for the AMT system might be slower, so you got less credit on your AMT tax return for less depreciation.  Therefore, you can get a credit on IRS form 8801.

Using your AMT Credit To Reduce Your Regular Tax Bill

You can also carry over unused AMT credit from previous years.  If your regular tax comes out to be less than the AMT amount then of course you have to use the higher of the two systems.  However, you can use prior year credit to reduce your regular tax if that’s the system you have to use.  Here’s an example.

  1. Your 2012 AMT credit is $4,000
  2. You do your 2013 taxes.  Under the regular tax system you owe $10,000.  Under the AMT you owe $8000.  Therefore you would have to use the regular tax since it’s higher than the AMT.
  3. You can use your 2012 AMT credit to reduce your tax bill, but not the full amount.  You can use it to reduce your regular tax down to the amount the AMT would have been.  So for tax year 2013 you can use $2,000 of your 2012 AMT credit.
  4. Use IRS form 8801 to get your AMT credit.

Using IRS Form 8801 When You Have Exercised an Incentive Stock Option

Fill out IRS form 8801 every year if you have exercised an incentive stock option, until you have used up the AMT credit.  Under the AMT, you are taxed on profit you might make in the future.  Even if you don’t sell your stock options, you have to report under the AMT the fair market value of the stocks.  Incentive Stock Options (ISOs) allow you to get stocks at a nice low price, below fair market value.  Under the regular tax system the value of the options you bought is the actual price you paid.  That’s your cost basis.  However, under the AMT, your cost basis is fair market value of the stocks…way more!

Use Form 6251 to Figure Your Alternative Minimum Tax

The IRS giveth and the IRS taketh away.  You get some nice deductions and tax credits plus other favorable treatment on some of your income, and this helps reduce your taxable income.  We like that.  But the AMT can take those nice tax benefits away, if it deems your income unworthy of such treatment.  You will be taxed differently, and this is called the Alternative Minimum Tax (AMT)We use IRS Form 6251 to figure whether we must pay the AMT.

IRA Form 6251

You will probably be filling out IRS form 6251 if your taxable income is over $50,000.  What the form does is add back in all your deductions, including your standard deduction and even your personal exemptions.  If, after filling out form 6251, your tax is higher, then that’s the one the IRS makes you use.  More money for them!

 How to Fill Out Form 6251, Line by Line

  1. This is your Adjusted Gross Income (AGI).  But it’s not the same as the AGI from your 1040 form.  Instead, take that 1040 version of your AGI and subtract your itemized deductions.   The AMT strips away your itemized deductions.  If you took the standard deduction, that goes away too. You also don’t get your deductions for personal exemptions.  So, people with lots of kids, who have several personal exemptions (you get one for each kid), adding this back in for the AMT has a pretty big impact.
  2. Medical expenses.  This will only affect you if you itemized your medical expenses.  You can still deduct them, but only if they add up to a lot.  If your deductions are more than 10% of your AGI then they’re allowed under the AMT.
  3. On the regular form 1040 you can deduct state and local taxes, real estate taxes and other taxes related to owning property, but not under the AMT.  Add these amount back in to your taxable income.
  4. On the regular form 1040 you can deduct the amount of interest you paid on a Home Equity Loan.  You still can under AMT rules, but not if you used the loan for anything other than buying, building or improving your home.
  5. Other itemized deductions.  Under the AMT, on form 6251: forget it.  You won’t be deducting things like business expenses if you are an employee.  This means getting reimbursed by your employer when you incur business expenses on your own dime.  Don’t do this if you are in danger of having to pay the AMT because Form 6251 adds these deductions back in.
  6. n/a
  7. Your state tax refund is not taxable on form 6251.
  8. IRS form 6251 will change how your investment interest is treated for tax purposes.  Better see the IRS instructions for form 6251.
  9. Now we’re getting into some very minute ways the AMT can change your taxes.  As we get further down the list of things to add back to your taxable income, it’s less and less likely that they will apply to you.  This one is depletion: are you involved in  mining activity?  how about the timber industry?  Only if you answer yes to these will line 9 of form 6251 have any effect on your tax rate.
  10. own your own business and it operated at a loss?  add it back in if you deducted it on form 1040.
  11. Did you claim a (Net operating loss) NOL last year too?  Then line 11 applies to you.
  12. Do you buy private activity bonds?  If not, skip line 12.
  13. Did you sell stock from your own small business?  No?  move on.
  14. Did you exercise Incentive Stock Options?  again, if not then next line.
  15. Are you involved in an estate or trust with a deduction?  if not, next line.
  16. Partner in a partnership?

There are 27 lines of things to add to your AGI on form 6251 but we’re going to stop here, just over halfway.  That’s because, as you may have noticed, the items to add to your new AGI under AMT rules are getting more and more obscure.  For a more complete look at  IRS form 6251 go directly to the source on the IRS website.  You’ll see the complete list of 27 things you may be taxed on if you get caught in the AMT web.

 

 

If the AMT Rate Kills You One Year, Hope Exists in a Credit Next Year

The Alternative Minimum Tax is not something anyone wants to fall victim to, but at least the rate cannot go as high as the regular tax.  When figuring your tax, the rate under the AMT system may turn out to be lower than your regular rate, so even though you will have to remove some of your nice deductions from your taxable income, you’ll be using a rate of 26% or 28%, depending on the amount of your taxable income under the AMT rules.  Regular rates for income taxes range from 10% to 39.6%.

Which Alternative Minimum Tax Rate Do I Use?

If your taxable income is less than $175,000 then your Alternative Minimum Tax Rate is 26%.  If it’s over that, the rate is 28%.  For the super rich, the AMT may end up totaling less money than the regular tax because the Alternative Minimum Tax Rate is so much lower than what regular income tax rates can be:  almost 40% for the top income tax brackets!

If You Get Caught in the AMT Web…

Let’s say you figure your taxes and it turns out you end up having to pay the Alternative Minimum Tax.  Well nothing you can do about it.  You can’t give back your high salary, change the law, or avoid paying.  But there is one light at the end of the tunnel, hope for the future let’s say… it’s the Minimum Tax Credit (MTC).

If in future tax years you don’t have to pay the Alternative Minimum Tax rate, then you can apply the Minimum Tax Credit.  The amount you paid in AMT over the regular tax system can be applied as a tax credit in following years.  That’s only if you’re not subject to the Alternative Minimum Tax rate for the year you’re using the MTC.

The form you use for the Minimum Tax Credit is IRS form 8801.  It’s available for download in PDF format at the IRS website here.  It’s called Credit for Prior Year Mnimum Tax- Individuals, Estates, Trusts.

If you use IRS form 8801 you cannot use form 1040 EZ to file your income tax return.  You can’t use form 1040A either.  You must use the full 1040 form.

Just Another Reason Why Using Tax Software is Best

If you were subject to the AMT, your income is probably complex enough that using tax preparation software is going to be extremely beneficial to you.  Commercial tax software (or their online versions) like TurboTax or TaxAct can help guide you through the awful maze of IRS forms and tricky concepts like the Alternative Minimum Tax rate.  You simply answer questions and the software does the rest for you.

 

 

 

New Rules for the AMT Tax Mean Savings for Many

The AMT tax has not been adjusted for inflation in past years.  Millions of taxpayers have been hit with the Alternative Minimum Tax over the past few decades, and some shouldn’t have had to pay at all.  That’s because as income rose with inflation, more taxpayers edged up into the AMT strike zone, which was originally set to capture only the wealthy among us.  Well $70, 000 was a huge amount of annual income twenty years ago but today it’s not as impressive.  But since the AMT was never adjusted for inflation, earning relatively less money  qualified lots of non-wealthy taxpayers for paying the AMT tax, meant for the wealthy.

Each year Congress would enact a temporary patch, keeping many taxpayers from having to pay the AMT.   This started under Bush in 2001, as part of the by now famous Bush-Era Tax Cuts.  These annual patches would raise the amount of income that was exempt from the AMT tax.  But nothing was ever guaranteed until 2012.  Congress was afraid to make the patches permanent because the money the government makes off the un-patched AMT tax is seven times what it is patched.  If they really needed money, they could simply not pass a temporary patch for a tax year and make $25 billion extra dollars.

The  American Taxpayer Relief Act of 2012

Now that’s all changed.  The  American Taxpayer Relief Act of 2012 has made a permanent fix for exemption amounts.  They will be raised each year according to inflation and fewer Americans will be caught in the web of the AMT tax.  The previous method of raising the exemption amounts didn’t necessarily reflect inflation.  The just raised the amounts but not always enough.

Still a Ways to Go, According to Some Critics of the AMT Tax

The way the AMT tax works is that is strips away many deductions so the taxpayer ends up with more taxable income.  One of the deductions not allowed under the AMT tax system is the state and local tax deduction.  Our fifty states vary wildly on how much their residents pay in taxes, and same goes for local governments.  Critics of the AMT tax argue that taxpayers who live in states with high taxes or towns with high taxes are unfairly hit by the AMT tax.  That’s because when you figure the AMT, you have to pay whichever is higher: the normal income tax amount or the AMT tax amount.  Adding back in high state and local taxes will more often push residents of high state tax areas into having to pay the AMT tax.

AMT Tax Exemption Amounts

For 2013 the AMT tax exemption amount for a single taxpayer is $51.9000.  Two years before that it was $48,450.

The Alternative Minimum Tax Exemption

Well we’ve already learned about the dreaded Alternative Minimum Tax.  If you missed it, read about this tax and how it works here.  Basically it’s a tax devised to prevent rich people from using too many loopholes to avoid paying income taxes.  The rich can loophole all they want, but the Alternative Minimum Tax (AMT) throws them back into the taxpaying system by levying a tax on them anyway, despite all the fancy deductions and exemptions their accountant may have come up with!

The AMT basically asks certain high-income taxpayers to re-calculate their income tax under this alternative system.  If they end up owing more under the AMT, then that’s what they pay.  In essence, what the AMT is doing is stripping away those nice deductions so the rich pay taxes.

Taking away deductions is not nice, but the AMT system also gives a nice fat exemption.  It’s called the Alternative Minimum Tax Exemption.

What is the Alternative Minimum Tax Exemption?

If you are figuring your income tax under the Alternative Minimum Tax, your taxable income will at first seem much higher because you’ve had to add back in all your tax deductions like child tax deduction and standard deduction and itemized deductions like travel expenses for your business and even some medical expenses.

The AMT also makes you add things to your taxable income that are normally tax-free.  One example of an income exclusion that won’t be excluded from taxable income anymore would be interest from private-activity bonds.  These are government bonds that are supposed to be tax exempt!

But the Alternative Minimum Tax Exemption works the other way: it subtracts income from your taxable amount.  The exemption changes to be adjusted for inflation each year, but the 2012 AMT exemption was $50,600 for individual taxpayers.  That’s quite a major chunk.  For married filing jointly taxpayers the 2012 AMT exemption was $78,750.  For married filing separately it was $39,375.

What About the AMT Exemption for Businesses?

Corporations are also subject to the AMT.  Only if your business made over $.75 million on average for the past 3 years will it be subject to the Alternative Minimum Tax.  Use IRS form 4626 located here on the IRS website.  You’ll also want to check out the Form 4626 Instructions.   The exemption can mean the business is too small to be subject to the AMT.  Different meaning for the word exemption here.  But the actual exemption amount, which the corporation can deduct under the AMT system, is $40,000.

 

 

How the Alternative Minimum Tax Got Out of Control

Back in the old days (the 1970s) when disco first hit the clubs and Jimmy Carter was President, our government tried to even things out for American taxpayers, financially.  It had been occurring to people that the very rich amongst us were paying very little in the way of income taxes.  The rest of us were paying quite a bit.

The IRS Plays Robin Hood, Sort Of

So our government created the Alternative Minimum Tax (AMT).  This was designed to make those rich folks pay more income tax.  More about the AMT here.   It stripped away many of their lovely deductions, which is how they were managing to pay so very little in federal income taxes.  It’s the IRS playing Robin Hood, who took from the rich and gave to the poor.

Of course one could argue that the second part of that phrase may or may not happen…is the IRS giving that extra tax money to the poor?  Probably not, but if you think of many tax credits available to the poor then yes, the IRS is truly playing Robin Hood.  Take from the rich with the AMT and give to the poo with the Earned Income Tax Credit (EITC).  The EITC allows very low income earners a tax break on a major chunk of their income, so as to encourage work.  Otherwise people might just stay unemployed since taxes would take out so much of their paychecks.

The Problem With the Alternative Minimum Tax

Anyway, back to the Alternative Minimum Tax.  Actually we’re going to need to talk about IRS tax brackets for a minute, too.  There’s a problem with the Alternative Minimum Tax, which is that more and more American taxpayers are caught in its web.  A much larger percentage of the taxpaying population is now subject to the AMT…whoppingly large, actually.  Some people who end up owing the AMT aren’t even that rich.  What happened?  Inflation.

That’s why we need to take a look at tax brackets, which aren’t affected by inflation.  Every year, things cost a little bit more.  Every year, salaries creep up to keep up with how much more things are costing.  Ever hear an elderly person say something like

“Back in my day,  a loaf of bread cost fifteen cents!”

Well yes, it probably did, but he was also making something like $5000 a year, too!  That’s inflation…things go up in price.  Well if we didn’t also adjust the IRS tax brackets for inflation, there would be hardly anyone at all paying taxes at the lowest tax brackets only.  Everyone would be paying the top rate…39%.  So we have to adjust the brackets every year.

But the wise folks who designed the Alternative Minimum Tax didn’t do it correctly: the thing is not adjusted for inflation!  So what was considered a phenomenally rich person in 1970, making $75,000, is now considered solid middle class today.  But that person is going to get whammed with the AMT because the AMT still thinks like it’s in 1970.

Bringing the Alternative Minimum Tax Into Today’s World

So starting in 2013, the Alternative Minimum Tax is adjusted for inflation.  Nice!  Fewer people will be considered so rich they have to pay this alternative tax.  $75,000 will no longer be considered absurdly rich.

 

What is the Alternative Minimum Tax?

Taxes are tricky: anyone who earns income should be paying federal income tax.  After all, that’s how our government pays for lots of things.  Money doesn’t come from nowhere and as US citizens we pay tax to support our federal government.  It’s our duty as citizens and we should be proud to do so.

Everyone Seeks Tax Advantages

Enter reality.  Nobody likes taxes and we all try to find ways to pay as little as possible.  We hire expensive accountants.  We pay others to prepare our federal tax forms for us, in hopes that they will find us a larger IRS refund or a smaller tax bill, whatever the case may be.

The way these accountants find you ways to save money on your federal tax bill is mainly through tax deductions and tax credits.  There are a lot of them out there, and of course it’s your right to find all the deductions and credits that apply to you.  You definitely don’t want to miss even just one!

An Unfair Tax System?

Some accountants are so good a finding tax advantages that their clients end up paying very little taxes.  It winds up being not such a fair taxation system after all.  Those of us who make more money can afford better tax accountants who will find ways to reduce taxes.  The rich end up paying a lower portion of their income towards taxes while middle class and poor taxpayers pay a higher ration of their income to the IRS.  Not fair!

Enter the alternative minimum tax (AMT).  The IRS pretty much said “phooey” to those accountants and created a bar below which no taxpayer can go below in terms of paying their share.  Even if someone qualifies for every tax deduction and tax credit ever created by the IRS, thus reducing the tax burden to a teensy amount, the alternative minimum tax makes sure they pay a fair amount…regardless of any long list of tax advantages they might have racked up.

How The Alternative Minimum Tax Works

If you make over a certain amount (around $52,000 for individuals in 2013) and claim lots of deductions and exemptions, you may have to figure your federal tax bill twice.  Once in the regular way and again using the alternative minimum tax.  If you’ve lowered your tax bill by a lot through deductions and exemptions then chances are you will pay more than you thought, because of the AMT.

Figuring your AMT is basically figuring your tax without the personal exemption and the standard deduction.  If you are subject to the AMT you also will not be able to deduct state and local taxes.  This ensures that you don’t cut your tax bill down so low that you are paying negligible or no tax at all.  You will use IRS form 6251 for the AMT.

There is something called the IRS Assistant, which is found on the IRS website.  It allows you to determine whether you will be subject to the AMT, without having to actually do your taxes.  It’s located here on their website.